Investors spooked as Ottawa throws foreign energy deals into question

Oil sands: Investors spooked as Ottawa throws deals into question

Just when Canadian stocks were starting to gain some traction and catch up with their American counterparts, the federal government decided to put up a potential roadblock. Its surprise rejection of Petronas’ $6-billion bid for Calgary’s Progress Energy Resources Corp. spooked investors and the fallout was quick: The S&P/TSX Composite’s oil and gas stock sub-sector opened down 1.5% on Monday, the first trading day after the rejection, and finished the week down 4.46%.

The federal government indicated it might consider a revised offer by Malaysian state-owned Petronas, but analysts are already warning the initial rejection will have wider repercussions for the Canadian stock market. After all, half of the TSX is comprised of resource companies that require massive amounts of financing to develop and sustain their operations.

Anyone now that invests in oil and gas companies, especially those based on takeover potential, has to revaluate why they’re buying an oil and gas company in the first place

“Anyone now that invests in oil and gas companies, especially those based on takeover potential, has to revaluate why they’re buying an oil and gas company in the first place,” said Barry Schwartz, a vice-president and portfolio manager at Baskin Financial Services Inc. “It’s clear the government has gone on the offensive. Takeover deals are still possible from non-state owned companies, but this changes the game.”

Petronas originally made its offer for Progress Energy in June, but it’s just one of several high-profile deals announced this year by foreign companies seeking to buy Canadian oil sands assets. Earlier this month, Exxon Mobil Corp. said it was buying Calgary’s Celtic Exploration Ltd. for $2.6-billion. The biggest deal, however, came in July when China’s CNOOC Ltd. made a US$15.1-billion bid for Nexen Inc., the sixth-largest independent energy producer in Canada.

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The rejection of the Petronas deal has worrying implications for CNOOC’s Nexen bid and the future of foreign investment in Canada’s resource sector. It’s estimated Canada needs more than $600-billion to develop the oil sands over the next decade, meaning foreign direct investment is necessary if the country hopes to fully exploit the resource.

The risk with these foreign deals being rejected is what it will do to financing in the energy sector

“The risk with these foreign deals being rejected is what it will do to financing in the energy sector,” said Charles St-Arnaud, Canada economist for Nomura Securities International Inc. “It can cause some of the financing for other projects, which are badly needed — there are a lot of pipelines that need to be built, a lot of projects that need cash — to slow as well.”

The government’s decision is already causing investors such as Mr. Schwartz to reconsidering some of their energy sector holdings.

“It has us wondering what we’re going to do about our Talisman position, for example,” he said. “One of the feelings we had about Talisman was maybe the new CEO is going to clean it up or it’s going to be sold. Maybe that’s not the case anymore. Until we get clear guidelines, there will be pressure on the Canadian oil and gas sector and takeover premiums will dissipate.”

The uncertainty over foreign investment rules comes at an inopportune time. Canadian stocks have actually been outperforming U.S. stocks during the past few months — something they haven’t done in more than a year. Since Sept. 6, when the European Central Bank announced its massive bond-buying program, the TSX is up 2.58% while the S&P 500 is up only 0.61%.

The energy sector has been a big factor in the TSX’s climb. Oil prices have recovered about 10% since bottoming out in June, when a barrel of oil, based on the Western Texas Intermediate standard, hit US$79.47. Canadian energy stocks, meanwhile, have soared 18.2% during that period. But maintaining that momentum might be difficult even if commodity prices rise.

“The rejection is far and wide reaching — it not only affects oil and gas companies, it affects other resource companies,” Mr. Schwartz said. “The fact of the matter is we have 45% of our exchange tied to resources, and this is another issue for us.”

Stéfane Marion, chief economist and strategist at National Bank Financial, said that although oil and gas stocks have performed well in the last six months, a lack of clarity over foreign investment in Canada has the potential to reverse the rally.

“The reality is, if you want to avoid a discount on the Canadian energy sector, you want to stop being a prisoner to only North American investment for Canadian energy,” he said. “You need to develop Canada’s energy sector with the help of foreign players.”

The fear now is that the government’s rejection of the Petronas deal was simply to prepare everyone for a rejection of the larger CNOOC bid for Nexen. Both Petronas and CNOOC are state-owned enterprises, which would make the federal government look consistent on the issue.

But Mr. Schwartz said that even if it does come to that (and he doesn’t believe it will), there are still opportunities in the Canadian energy sector for investors. He points out fears that the government will block foreign takeovers of Canadian resource companies have opened up attractive valuations for some of the country’s larger oil and gas firms.

“All of this could potentially lead to more money flowing from the juniors to some of these, for lack of a better word, forgotten giants like Suncor and Canadian Natural Resources,” he said. “These are companies that have fundamentally good numbers and are the cheapest they’ve been in a long time.”

But Mr. Marion said that the biggest step the Canadian government can take to help the energy sector is to make it clear it is open to investment from Asia. He expects energy stocks will suffer until the government more clearly defines its position, one way or the other.

“You can’t avoid these state-owned enterprises if you’re going to find new markets in Asia,” he said. “Opening up to new markets means dealing with different ways of doing business. The reality from the Asian standpoint is, that state-owned enterprises are very prominent players there.”

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